Underlying Asset

An underlying asset is a security, commodity, or other asset that is the subject of a derivative contract. The value of the derivative contract is based on the value of the underlying asset. For example, in a futures contract, the underlying asset is the commodity that is being traded. The value of the futures contract will fluctuate based on the price of the underlying commodity.

There are many different types of underlying assets that can be used in derivative contracts. Some common underlying assets include stocks, bonds, commodities, currencies, and interest rates. The type of underlying asset that is used will determine the type of derivative contract that is created.

Derivative contracts are used by investors to manage their risk and to speculate on the future value of an underlying asset. For example, an investor who is bullish on the future value of a stock may buy a call option on that stock. A call option gives the investor the right, but not the obligation, to buy the stock at a certain price in the future. If the stock price rises above the strike price of the option, the investor can exercise the option and buy the stock at the lower price. This will result in a profit for the investor.

On the other hand, an investor who is bearish on the future value of a stock may buy a put option on that stock. A put option gives the investor the right, but not the obligation, to sell the stock at a certain price in the future. If the stock price falls below the strike price of the option, the investor can exercise the option and sell the stock at the higher price. This will result in a profit for the investor.

Derivative contracts can be used to manage risk in a number of ways. For example, an investor who is concerned about the volatility of a stock may buy a put option on that stock. This will protect the investor from losses if the stock price falls. Alternatively, an investor who is looking to speculate on the future value of a stock may buy a call option on that stock. This will allow the investor to profit if the stock price rises.

It is important to note that derivative contracts are complex financial instruments and can be risky. Investors should carefully consider the risks involved before trading in derivative contracts.